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Investment Outlook 2025
Central banks start cutting rates
In 2022 and 2023, headlines were dominated by central banks raising interest rates to tackle rising prices as the world lifted restrictions from the Covid pandemic. This year, the same headlines were telling a different story. Inflation has been steadily falling towards central banks’ 2% target while the global economy showed its strength. This meant central banks were finally comfortable enough to start cutting interest rates.
The Bank of England, US Federal Reserve (Fed) and the European Central Bank all started cutting rates in the second half of 2024. This trend is expected to continue next year with between two and five more cuts expected from each of the central banks.
This time it’s different
Normally when central banks start cutting rates, economies aren’t in too great of shape. Let’s look at the US as an example. Since 1974, seven out of the nine previous times the Fed have lowered interest rates, the US was in a recession or near one, and markets were weak on average – falling by more than 10% from their recent highs. However, that is not the situation we’re seeing now.
Instead of a recession, where the economy contracts for two consecutive quarters, the US has actually been growing. This comes with a strong jobs market where the unemployment rate has stayed low. Investors have been encouraged by this which has resulted in stock markets to perform well throughout 2024.
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Uncertainty
2024 did come with a lot of unknowns. Elections, UK Budget and ongoing geopolitical tensions did cause some nervousness for investors which sparked some occasional volatility.
In November, Donald Trump won the US presidential election. We are likely to see a shakeup in legislation from the new president which could come in the shape of tax reforms, deregulation plans and a shift in international trade.
The UK Labour government’s Budget was expected to be the most significant in years. Rises to employer national insurance contributions will mean increased costs for businesses which could be passed on to customers through rising prices for goods and services. This means inflation may begin to pick up pace again and rise above the central bank’s 2% target and cause the Bank of England to rethink its plans for how much it brings down interest rates in 2025.
Geopolitical risks such as ongoing dynamics between the US and China, as well as conflict within the Middle East and Ukraine, impacted market sentiment and global trade.
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Broadening earnings growth
At the beginning of this year, earnings growth in the US was dominated by a small group of technology giants which made up the so-called ‘Magnificent 7’ (Amazon, Apple, Alphabet, Microsoft, Meta, Nvidia and Tesla). As the year went on, this dominance began to ease as other companies in the market started contributing heavily to this growth. This is expected to continue into 2025 with forecasted earnings growth expected to rise from 9% this year, to 14% next year.
Our asset allocation
Stock markets have performed well this year off the back of strong corporate earnings and a stable global economy. Bonds have also been producing attractive yields as falling inflation has meant central banks could begin cutting interest rates.
The experts at Coutts, the bank behind Royal Bank’s investments, have been leaning into ‘risky’ assets this year such as stocks and high yield bonds. The investment team actually took profits from high yield bonds earlier this year as well as shifting to a more global approach within their equity allocation.
Equity – Our investments continue to be weighted toward risky assets, specifically global equities, which should include multinational companies with strong profit-making potential.
Fixed income – Within the bond space, we lean away from Japanese government bonds as it is the one region where inflation and interest rates are rising rather than falling.
Outlook for 2025
We are optimistic about what’s to come in 2025. Our short-term focus will be on continued moderate economic growth, rising wages and lowering global interest rates which should all be good for corporate earnings.
Beyond next year may not be as attractive, however. Risky assets, like what we’ve mentioned before, already have high valuations. But with that said, they were also seen as expensive a year ago too so it’s hard to judge exactly where the ceiling is for markets.
Inflation
Now that interest rates are coming down, there is a chance that inflation could spike again. If it does, then central banks may have to hold off making as many rate cuts as initially expected.
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Recession
Industry leading indicators are at levels that suggest a recession is possibly around the corner for the US. One indicator, the ‘Sahm Rule’, was triggered earlier this year when the unemployment rate jumped up. The environment we are in now is unique though, and so these indicators may not be as accurate as they usually are – but that’s not to say they are wrong.
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